After years spent launching and growing your business, the day will finally arrive when you can sit back and enjoy the fruits of your labor. But, just as starting your business involved hard work and planning, the process of exiting your firm can be a long and challenging process.
Many entrepreneurs put off making decisions about the disposition of the business until their departure is imminent. Waiting until the last minute to put together an exit strategy can, however, prove to be an expensive mistake. Unanticipated events—such as a health crisis, a divorce, or the death of a business partner—may force you to dispose of the business quickly, and at a loss. Having a transition plan in place will greatly improve the chances that you will be able to draw income from the business to support your retirement needs, and ensure that the business is passed on as you had intended.
Closely-held companies often have in place a business succession plan that establishes a monetary value for each owner’s business interest before the need arises. A succession plan typically has at its center a buy-sell agreement, or a contract that obligates the owner’s estate to sell his or her shares for a predetermined price to partners or shareholders, to the business itself, or to both. Buy-sell agreements are often financed with life insurance.
If you wish to pass on the business to family members, consider in advance the best succession method. Transferring ownership of the business to a relative at no cost can result in substantial gift or estate taxes if it is done all at once. To take advantage of gift tax exclusions, start giving stock in the company to future heirs years before the expected transition. This could reduce or eliminate the taxes owed when the business finally changes hands. You can also sell the company to family members, though there may be tax obligations for the seller if the business is sold at a reduced rate.
A private annuity can provide a tax-efficient means of transferring ownership to the next generation. Under the terms of a private annuity contract, the heir agrees to pay the owner a certain sum of money at set intervals, usually for the duration of the owner’s lifetime, in exchange for receiving the property. This type of arrangement can help you to secure a retirement income, but carries the risk that the heir will default on the annuity obligations.
If there is no co-owner or family member prepared to take over the business, you could sell the firm to current employees. This can be the best option for smaller businesses with low cash flow levels that might have difficulties attracting the interest of third-party buyers. Employees already involved in the management of the business will have a good idea of what the company is worth, and have the knowledge necessary to keep the business running after your departure. It may be possible to structure the sale so that the agreed price is paid off over time, thus producing an income for the former owner.
If you are considering selling to employees in the future, you may want to establish an employee stock ownership plan (ESOP). In addition to serving as a performance incentive, there are substantial tax advantages associated with selling a business to an ESOP.
It may also be possible to recruit an outside buyer for your company. This route can be especially lucrative if the business is growing quickly and market conditions are favorable. A business appraiser can help you determine what price you might achieve on the open market, and a business broker can assist you in locating a buyer. Keep in mind, however, that preparing a company for sale can involve a great deal of work. Carefully review your financial statements and operations for any weaknesses that could make the company less attractive to a potential buyer. With sufficient preparation, you may be able to greatly enhance the value of your company before putting it up for sale.
Regardless of which exit strategy you choose, it is best to make the transition a gradual one. If you intend to pass on the business to family members or employees, appoint a successor to take over as head of the company while you are still involved in the business. In some cases, you may want to make arrangements to remain involved in the business as a consultant or employee even after the firm has been sold or otherwise transitioned to a new owner. If the business is owned by family members, your connection with the company may never be completely severed.
Planning for the day when you will leave your business is a complex undertaking. Call us to discuss how you can manage your income from the disposition of your business, and plan for a comfortable retirement.